FRM- 2

Question 1

Return on Portfolio of 2 Assets

Answer 1

1. Weighted- Average of Returns on Individual Assets

2. Investor to Invest Fully

Question 2

Standard Deviation of Portfolio of 2 Assets

Answer 2

1. Not Weighted- Average of Standard Deviation of Returns on Individual Assets
2. Cross- Terms are Involved and Weights Do Not Add to One

Question 3

Standard Deviation

Answer 3

Volatility of Returns

Question 4

Delineating

Answer 4

Representing Pictorally

Question 5

Correlation

Answer 5

+1 To -1

Question 6

Correlation= +1

Answer 6

1. Nothing has been Gained from Diversifying

2. Straight Line in Return- Risk Space

Question 7

Correlation= -1

Answer 7

1. Less Risk
2. Positive Investments in Both Assets is Required to Have a Zero- Risk Portfolio
3. Graph is Between Risks of Both Securities and Zero- Risk

Question 8

Power of Diversification of Investments

Answer 8

Reduce Risk

Question 9

For Correlation Between -1 & +1

Answer 9

1. Graph will Lie in the Region Between Straight Line for Correlation +1 & Correlation -1
2. Positive Investments

Question 10

Value of Correlation Can Be Such That

Answer 10

Minimum Risk of Portfolio Cannot Be Less Than the Risk of Least- Risky Asset in the Portfolio

Question 11

Portfolio Possibility Curve

Answer 11

Curve Along Which All Possible Combinations of Assets Must Lie in Return- Risk Space

Question 12

Concave Curve

Answer 12

1. Higher- Return and Higher- Risk

2. Return of the Portfolio Will Be Greater Than for Same Portfolio With Correlation =+1

Question 13

Convex Curve

Answer 13

1. Higher- Return and Lower- Risk

2. Risk of a Portfolio Will Be Less Than for Same Portfolio With Correlation =+1

Question 14

Minimum Variance Portfolio

Answer 14

Value of Investment

Question 15

Combination of Two Portfolios of Same Assets

Answer 15

Is a Portfolio of That Same Assets

Question 16

In All Possible Combination of All Risk Assets, Investors Look For

Answer 16

1. Higher- Return With Same Risk

2. Lower- Risk With Same Return

Question 17

Efficient Frontier

Answer 17

1. Between Global Minimum- Variance Portfolio and Maximum Return Portfolio
2. Concave Curve

Question 18

Short Sale

Answer 18

1. Selling a Security Without Owning It
2. Borrowing a Security and Selling It
3. Borrowing Cost is Same as Expected Return on Security Borrowed or Dividend on the Security If Any

Question 19

Effect of Short Sale on Efficient Frontier

Answer 19

1. No Upper Bound

2. Lower Bound Remains Global Minimum Variance

Question 20

If Short Sale is Done Using Selling of Security With Higher Return

Answer 20

1. Leads to Higher- Risk (Obvious)

2. Leads to Lower- Return Due to a Negative Term in the Equation For Expected Return of Portfolio

Question 21

Separation Theorem

Answer 21

Ability To Determine the Optimum Portfolio Without Having to Know Anything About The Investor

Question 22

Rotating the Ray of Efficient Frontier With Risk-less Lending and Borrowing Counter- Clockwise

Answer 22

We Can Get The Tangent to the Efficient Frontier of Portfolio

Question 23

Beyond Tangent We Cannot Go

Answer 23

1. Since Efficient Frontier Shows All Possible Combinations

2. No Line Lies Above the Tangent Line

Question 24

Considerations In Determining Inputs

Answer 24

1. Inflation- Adjusted Inputs
2. Input Estimation Uncertainty
3. Correlation Over Different Time-Periods
4. Short- Horizon and Long- Horizon

Question 25

Need of Inflation- Adjusted Inputs When

Answer 25

Investment Horizon is Measured Over Decades

Question 26

T-Bills Are

Answer 26

Partial- Inflation Hedge

Question 27

Returns Have To Be Adjusted for

Answer 27

Inflation in the Previous Years and in the Coming Years

Question 28

Historical Analysis Based on Longer Time Period

Answer 28

Is Able To Capture the Changing Pattern in Much More Detail

Question 29

Characteristics of Security Returns

Answer 29

Changes Over Time

Question 30

Bayesian Analysis

Answer 30

Variance of Predictive Distribution of Returns

Question 31

Correlation Also Changes Over Time

Answer 31

1. Due to Macro-Economic Conditions

2. E.g. Correlation Between International Market Index

Question 32

Increase in Inflation Uncertainty

Answer 32

Stock- Bond Correlation Rises

Question 33

Short Time- Horizon Vs. Long Time- Horizon

Answer 33

1. If Returns for Each Year Are Auto-Correlated then Risk Depends Upon Which Time- Horizon is Taken
2. E.g. T- Bills

Question 34

T- Bills Are Auto- Correlated

Answer 34

1. Standard Deviation Lower for Lower Time- Horizon

2. No Effect on Return

Question 35

When Value of X for Which We Get Minimum Variance Portfolio is Positive

Answer 35

It Means Some Combinations of Risky Assets Are Not Efficient

Question 36

When Value of X for Which We Get Minimum Variance Portfolio is Positive

Answer 36

1. It Depends on Correlation

2. Exploits Diversification of Portfolio

Question 37

Efficient Frontier With Tangent Portfolio

Answer 37

3 Possibilities:

1. Risk-Less Borrowing Allowed
2. Risk-Less Borrowing Not Allowed
3. Risk-Less At A Different Risk- Free Rate

Question 38

Risk-Less Borrowing Not Allowed

Answer 38

After Tangent, Same As Efficient Portfolio of Risky Assets

Question 39

Risk-Less At A Different Risk- Free Rate

Answer 39

1. Two Points of Tangent

2. Some Portfolios in Which Investors Can Apply Which Are Between Two Tangent Points